With climate change accelerating, investors worldwide are being called upon to actively support mitigation methods through their investments. To enable private sector investors to contribute, climate finance needs to be shaped into a financially sound and attractive business proposition, offering market-based risk-return profiles as well as clear growth prospects.
While the United Nations claims that it is possible to limit the increase in global mean temperature, it underlines that at least USD 100 billion needs to be mobilized for mitigation actions every year to sustainably reduce CO2
Creating an investment opportunity
Parties in developed countries continue to make progress by joining forces to mobilize the necessary means. While a substantial part of the required financing stems from the public sector, there is an urgent need for more private sector financing to complement these efforts.
Mobilizing private funds for climate change mitigation has been challenging, however: with emerging market investments already deemed risky, venturing into the little developed investment topic of climate finance in emerging markets is more of a challenge than most pension fund managers are prepared to tackle.
This is a pity, really, and a huge opportunity lost. After all, rising incomes in the developing world are giving birth to a whole new class of consumers ready to spend their hard-earned income on products and services we take for granted. The International Energy Agency expects that 4 billion air conditioning systems will be sold over the next 10 years. These systems will require the equivalent of the combined electricity capacity of the US, the EU and Japan today. Therefore, the investment opportunity of climate finance, particularly in emerging economies, should have investors flocking to the topic. The task at hand is to ease their way into the area.
Accessing this growth market through blended finance
This is where public-private partnerships come in. Traditionally designed to leverage public funding with private investments, blended finance solutions can provide the necessary risk protection to allow private sector investors to safely explore new investment opportunities. The beauty of this approach is that it works – as illustrated by the following example: in 2009, the German Federal Ministry for the Environment, Nature Conservation, Building and Nuclear Safety and Germany’s development bank KfW set up an investment company under Luxembourg law. Designed as a public-private partnership, the Climate Fund, whose Switzerland-based manager is responsAbility, tackles the shortage of financing for low-carbon projects in developing economies. The Climate Fund – the only one of its kind with a global focus on emerging economies – focuses on financing energy efficiency and renewable energy projects for SMEs and private households, primarily in cooperation with local financial institutions, but also financing energy SMEs directly. While these areas do not require subsidies to unleash their potential, they remain insufficiently served by private capital providers.
First-loss guarantees by the public sector
To facilitate private sector investments, public investors provide a first-loss risk cushion, allowing private investors to participate through senior shares or notes with a limited risk. Additional public funding is made available for Technical Assistance, providing advisory support to get new energy projects off the ground and build and broaden the Fund’s investment universe.
Ten years down the line, the Climate Fund has an invested portfolio of over USD 500 million, with commitments from investors amounting to USD 667 million. Private investors include pension funds, banks, foundations and investment funds attracted by stable returns from a well-diversified portfolio and the opportunity to access this innovative and growing investment universe. Working with 34 partner institutions, the Fund plays an active role in boosting green lending and increasing awareness about its potential in the 25 countries where it is invested. Using its well-endowed Technical Assistance Facility, which is financed by public sector donors, the Climate Fund actively works with banks to develop and promote green loans in the context of their market.
Developing the green market to drive demand
The Fund creates the demand it seeks to fulfill: Unless explicitly encouraged and closely supported in the process, most banks in emerging economies would shy away from the task of developing a green lending portfolio and miss out on the underlying opportunity. Take India-based RBL Bank, for instance, one of India’s fastest-growing private sector banks. Having started out with a strong focus on agriculture, RBL Bank introduced climate loans for the agricultural sector in 2013. The Climate Fund not only provided the financing, its advisory team also supported the bank with underlying research and helped them come up with a loan product for energy-efficient drip irrigation systems. With the system, sugarcane crops grow up to 30% higher while using 40% less water. Farmers further benefit from wells that last throughout the dry season, allowing them to grow vegetables all year round to generate additional income.
The impact: CO2 emission reduction
Since its inception in 2009, the Climate Fund has financed over 74,000 energy loans disbursed by local financial institutions. Financed projects range from the replacement of kitchen appliances in Ecuador to the construction of a small-scale hydropower plant in Georgia. Together, the financed projects will contribute to reducing CO2 emissions by 12.8 m tonnes over their lifetime. This is more than the annual CO2 emissions of a country like Georgia or the heating of 4.5 million households in Switzerland per year.
At the same time, the Fund finances energy companies like SolarNow. Active in Uganda and Kenya, the company sells and finances off-grid solar home systems for households, small businesses and farms. Besides solar panels and batteries, SolarNow also sells energy-efficient appliances like torches, electric irons, refrigerators and solar pumps. It is SolarNow’s ambition to transform the lives of East Africans, and with each kerosene lamp that is replaced with solar, clients report not only a well-lit home, but also improved health and safety and greater connectivity to the outside world.
A seasoned pioneer
Over the first decade of its existence, the Climate Fund has successfully developed a whole new investment universe in developing countries. Thanks to the first-loss cushion provided by public sector funding, private sector investors can safely access this new investment universe to further diversify their portfolio and take a conscious step towards contributing to mitigating climate change.
With a 10-year track record, the Fund is ready to sustainably scale its approach with more private-sector funds. And responsAbility is actively developing further initiatives, including a private debt fund targeting access to clean power in Africa and Asia, financing companies with similar business models to SolarNow.
